The Deflationary Canary: China Tier-1 Home Prices Post First Decline Since May 2015

Over the weekend, China's National Bureau of Statistics reported 70-city housing price data. While the overall market was stable in January compared with December 2017, there was one surprise: in tier-1 cities, housing prices fell on a year-over-year basis for the first time since May 2015, amid an ongoing broad slowdown across the entire housing market.

This can be seen in the Goldman chart below, which shows the first Y/Y contraction in what has traditionally been the most important asset for China's middle class after three years of price growth.

Overall, China's housing market remains a tale of two city types: Tier 1 cities, or the most populous, expensive, and politically important, which after soaring in late 2016 during the height of the latest Chinese housing bubble has seen a dramatic slowdown following broad concerns most Tier-1 housing had become unaffordable, and as of January, has slid into contraction for the first time in 3 years, and then there all other cities. For those unfamiliar, here is a more detailed breakdown:

The Chinese government doesn’t have an official definition for the tiers and many businesses use slightly different methods for classification such as Gross Domestic Product (GDP), political administration, population size, development of services, infrastructure, cosmopolitan nature, retail sales etc. However, it is generally considered that there are four tiers with different consumer behaviours, income levels and business opportunities.

GDP: Generally, each city is first classified by GDP. China’s cities range from US$300 billion to minor cites with GDP under US$20 billion:

  • Tier 1 – all first tier cities have a GDP over US$300 billion
  • Tier 2 – cities with GDP of US$68–299 billion
  • Tier 3 – cities with a GDP of US$18–67 billion
  • Tier 4 –a GDP below US$17 billion

Politics: China has four levels of political administration and the two special administrative regions of Hong Kong and Macau:

  • Tier 1 –cities directly controlled by central government
  • Tier 2 – provincial capital cities and sub-provincial capital cities
  • Tier 3 – prefecture capital cities
  • Tier 4 – county-level cities

Population: The core city and urban areas surrounding the main city are taken into account to define metropolitan areas:

  • Tier 1 – cities with more than 15 million people
  • Tier 2 – cities with 3–15 million people
  • Tier 3 – cities with 150,000–3 million people
  • Tier 4 – cities with fewer than 150,000 people. Rural areas are villages close to Tiers 2, 3 and 4 cities.

With that in mind here are the latest pricing details from Goldman:

  • Commercial housing prices in the primary market in the 70 cities (weighted by population) increased 0.5% month-over-month in January after seasonal adjustment, same as December.
  • Out of the 70 cities monitored by China’s National Bureau of Statistics (NBS), 67 cities saw housing prices increase in January on a M/M basis, same as December.
  • On a month-over-month basis, property price appreciation slowed in tier-1 and 4 cities, accelerated in tier-2 cities and was roughly unchanged in tier-3 cities. Price appreciation was 0.2%/0.5%/0.6%/0.5% month-over-month after seasonal adjustment in tier-1/2/3/4 cities respectively.

Where the data was more remarkable was on a Y/Y basis: here commercial housing price appreciation continued to slow to 4.8% in January in the 70 cities, from 5.2% yoy in December. And the kicker: Tier-1 cities property prices fell on a year-over-year basis in January, the first year-over-year fall since May 2015.

Curiously, from this month onward, China's official data keeper, the NBS, will only release price indexes for commercial properties in the 70 cities and stopped releasing price indexes of social housing in the primary market. This is notable because major banks, such as Goldman, used to track overall housing price in the primary market (commercial and social housing) in the 70 cities, and from this month onwards, Goldman cautions that it shift to tracking commercial property prices.

It is unclear how skewed the data will be from the elimination of social housing data: historical data showed average price change of overall primary market (commercial and social housing combined) in the 70 cities has been very similar to the price change of commercial properties only, although the latter is slightly more volatile than the former.

Separately, there is was no standalone release of January property construction and transaction data by the NBS because of the Chinese New Year, but local housing bureau's data on top 30 cities property transactions showed property transaction volume slowed modestly in these 30 cities in January from December, after adjusting for the Chinese New year holiday and other seasonalities.

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So is the first slowdown in Chinese top city prices a harbinger of deflation in the world's economic growth dynamo, and by extension, the entire world? After all, as we have discussed previously, (most notably in "Why The Fate Of The World Economy Is In The Hands Of China's Housing Bubble"), few price trends are as important for the global economy as Chinese home prices.

For the answer we use our favorite leading tracking indicator of Chinese inflation - and deflation: the country's credit impulse, as calculated each month by Bloomberg.

What we find is that despite record new loan creation last month, partly due to the crackdown on shadow banking China's credit impulse remains in contraction, where it has been for the better part of the past year.  And as the chart below shows, superimposing first-tier Chinese home prices with the country's credit impulse (net of a 6 month lead) really tells the entire story: without much more credit injected into the Chinese economy...

... expect further downside to home prices, not only in Tier 1 cities, but across the entire Chinese housing market.

Which is troubling, because the last two time China's housing contracted, the result was a deflationary wave unleashed across the globe; in fact some have speculated that the reason for the near-bear market in late 2015 and 2016 as well as the Fed's derailed plans to hike rates in 2015 was largely due to the deflationary spark prompted by the sharp contraction in Chinese housing prices.

Which obviously means that with the Fed poised to hike 3 (or 4) times in 2018, it would be prudent to keep a close eye on not only trends in China's housing market, but also China's credit impulse, which over the past decade has consistently been one of the most informative leading indicators of inflation or the lack thereof.